Can listed infrastructure continue to deliver in inflationary times?

That said, it is hard to argue against the long-term benefits of global listed infrastructure. Essentially, it is the physical assets that provide basic services to modern society, including utilities, transport, and communication assets.

Infrastructure will always need to be built and renewed – and the world is well behind where it needs to be. Figures from Oxford Economics in 2017 indicated that global infrastructure investment needed to be $94bn (£75.5bn) between 2016 and 2040 to close infrastructure gaps.

The ongoing supply and demand issues from Covid-19 and the move to decarbonisation are likely to have seen that number grow significantly since then.

The benefits of investing in infrastructure

The benefits are there to see; it is a low beta asset class that has demonstrated its ability to be lowly correlated to traditional investments, while also retaining a number of defensive characteristics. The defensive nature is supported by the fact infrastructure has an explicit link to inflation, courtesy of regulation, concession agreements or contracts. 

Research shows around 70 per cent of investment assets owned by listed infrastructure companies have an effective means to pass through the impact of inflation to customers, to the benefit of shareholders.

We have to remember infrastructure sits in the real assets bucket and the replacement costs for this asset rise in line with inflation. 

Utilities, developed roads, oil pipelines, airports, mobile towers, and bulk rail are examples of sectors with such protection in place.

This, coupled with steady yields in what was previously a low interest world, have quickly made them popular with retail investors.

Is high inflation a threat?

But does the asset class look as attractive now we are in an inflationary environment with rising interest rates?

In the annus horribilis that was 2022 for investors, global listed infrastructure fell only 5 per cent, compared to significantly larger falls for both global equities (-18 per cent) and bonds (-16 per cent).

But there are now challenges on the horizon as the sector confronts a more inflationary environment, where volatility is also on the rise. We have to remember infrastructure sits in the real assets bucket and the replacement costs for this asset rise in line with inflation. 

Utilities are arguably the most defensive of the infrastructure sub-sectors given the embedded demand for the likes of water, gas, and electricity.

In addition to this we must remember that while infrastructure typically generates greater revenues and profits thanks to inflation linkage, this has started to be offset by the rise in interest rates.

This not only increases the cost of debt in an area where a number of projects are highly geared, but infrastructure is often thought of as a yielding bond proxy asset.

As the risk-free rate of government bonds has risen, investors are demanding a higher return on these assets as well, so prices need to fall.

This is where the challenges come in as a number of listed infrastructure funds are now offering unattractive yields in comparison to that risk-free rate.

Different strains and opportunities across sectors

Utilities are arguably the most defensive of the infrastructure sub-sectors given the embedded demand for the likes of water, gas, and electricity for people to live their lives.

As Matthew King, lead portfolio manager for global listed securities at Eaton Vance, points out: the sector is also continuing to benefit from the fact we are seeing the proliferation of clean energy investments being accelerated by the Inflation Reduction Act in the US and renewable energy directives in Europe, which are a boost to existing capital programmes.

He says: “The focus on energy transition, energy security and existing asset replacement ensures solid, long-term secular growth for the utility sector.”

Not only is government support for global listed infrastructure growing, but private funding is also likely to remain strong.

While the communications sector suffered in 2022, it is arguably one of the strongest from a long-term perspective, aided by good earnings and cash flow visibility.

Digital technologies are now embedded in our everyday lives. And for me, digital infrastructure covers three specific areas: mobile towers, data centre and fibre optic cables – all of which have major barriers to entry.

The transportation sector is probably the most challenged sector at the moment, with the likes of airports, general traffic, or freight-related movement still below pre-pandemic levels. Although valuations are looking attractive.

Recession-proof and longer-term trends

While the income element is perhaps not as attractive in this environment – a fact that will likely see some 'bond tourists' depart the sector – we do have series of long-term trends that do not impact the growth story. 

Not only is government support for global listed infrastructure growing, but private funding is also likely to remain strong. Add in the multi-decade growth story of decarbonisation and the growing need for digital infrastructure and you can see the benefits of investing for the long term.

Global listed infrastructure has shown itself to be a good defensive option historically.

Income may have stolen the headlines, but it has only been part of the story. I was pleasantly surprised to see that in almost two decades the FTSE Global Core Infrastructure sector has outperformed global equities, returning 373 per cent versus 331 per cent for the MSCI World.

Research from First Sentier also highlights the fact that the sector does possess recessionary traits.

Having undertaken modelling to estimate the potential impact of a recession on different sub-sectors within the asset class, this analysis suggested listed infrastructure may suffer less than half the earnings impact relative to broader markets in this scenario, represented by the S&P 500 index.

Global listed infrastructure has shown itself to be a good defensive option historically. It is a great diversifier from both a growth and income perspective in uncertain times, and there is no better way to manage risk than to diversify.

Traditional players

Those wishing to access the asset class may want to consider the First Sentier Global Listed Infrastructure fund, managed by Peter Meany and Andrew Greenup.

The managers build a 40-strong portfolio that specifically targets economically sensitive assets with barriers to entry and pricing power. Largest exposures at present include electric utilities (33 per cent) and highways and rail tracks (17 per cent).

Another is the M&G Global Listed Infrastructure fund, managed by Alex Araujo.

He invests in three distinct infrastructure categories:

• economic infrastructure (65 per cent to 75 per cent of the portfolio), such as utilities and energy companies plus transport-linked areas including toll roads and airports;
• social infrastructure (10 per cent to 20 per cent) in areas like health, education and civil; and
• evolving infrastructure (15 per cent to 25 per cent) such as communications (mobile towers and data centres) and transactions, like payment companies and royalties.

Araujo targets companies with critical physical infrastructure, long-term concessions, or perpetual royalties. They need to be paying some level of dividend and have a market cap over $1bn. Araujo will want to know about the dividend situation – its history and outlook – the capital discipline of the firm, and sustainability credentials.

The digital alternative

Schroder Digital Infrastructure fund seeks to take advantage of the ever-increasing demand for digital infrastructure and the sustainable transition to a digital economy. It holds around 40 stocks invested around the world in a mixture of emerging and developed markets.

The fund has three main areas it will invest in: macro towers, fibre optic cables and data centres.

Darius McDermott is managing director of FundCalibre